Fed to Buy Extra $600 Billion of Treasuries to Boost Growth

The Federal Reserve will buy an
additional $600 billion of Treasuries through June, expanding
record stimulus and risking its credibility in a bid to reduce
unemployment and avert deflation.

Policy makers, setting a pace of about $75 billion of
purchases a month, “will adjust the program as needed,” the
Fed’s Open Market Committee said today in a statement in
Washington. The central bank left unchanged its pledge to keep
interest rates low for an “extended period” after Chairman Ben S. Bernanke said it could be modified in some way.

While Bernanke’s near-zero rates and $1.7 trillion in asset
purchases helped end the recession, the Fed said progress has
been “disappointingly slow” in bringing down joblessness close
to a 26-year high. The risk is that the move doesn’t work or
fuels inflation and asset bubbles, said Paul Ballew, a former
Fed economist and a senior vice president at Nationwide Mutual
Insurance Co. in Columbus, Ohio.

“The Fed has been dissatisfied with the pace of
recovery,” former Richmond Fed President J. Alfred Broaddus
said. “The long-term mandate is to conduct monetary policy
consistent with full employment and stable prices. We are a long
way from that.”

The FOMC kept its benchmark interest rate target for
overnight interbank loans at zero to 0.25 percent, where it has
been since December 2008. New York Fed President William Dudley,
who serves as FOMC vice chairman, said Oct. 1 that purchases of
$500 billion would be about equivalent to reducing the rate by
0.5 to 0.75 percentage point.

Boost Growth

Bernanke, in an opinion article for the Washington Post
released late today, said the purchases should boost economic
growth through lower borrowing costs and higher stock prices and
that concerns about the strategy are “overstated.”

“This approach eased financial conditions in the past and,
so far, looks to be effective again,” he said.

The Standard & Poor’s 500 index rose 0.4 percent to
1,197.96 at the 4 p.m. close of trading in New York. The dollar
weakened 0.7 percent against the euro to $1.4139 after touching
a nine-month low of $1.4179.

Central bankers acted a day after Americans voted in
midterm elections to hand control of the House to Republicans
and slim down Democrats’ Senate majority, intensifying political
gridlock on fiscal issues and putting more of the burden for
sustaining growth on the Fed. The FOMC’s schedule of eight
meetings in 2010 was announced in June 2009.

Asset Purchases

Fifty-three of 56 economists surveyed by Bloomberg News
last week predicted the central bank would announce asset
purchases today, with 29 forecasting a pledge to buy $500
billion or more.

“They did a little bit more -- that suggests they want to
add an exclamation point to what they’re doing,” Broaddus said
in a Bloomberg Television interview.

Including Treasury purchases from reinvesting proceeds of
mortgage payments, the Fed will buy a total of $850 billion to
$900 billion of securities through June, or about $110 billion
per month, the New York Fed said in an accompanying statement.

The Treasury 30-year bond fell the most in almost two
months after the New York Fed said in a separate statement that
86 percent of its purchases will target bonds coming due in 2 ½
to 10 years.

“Only a small fraction of the buying will be beyond the
10-year note,” said Paul Zemsky, the New York-based head of
asset allocation for ING Investment Management, which oversees
$550 billion.

Temporarily Relaxed

Assets will have an average duration of five to six years,
and the central bank temporarily relaxed a 35 percent per-issue
limit on its securities holdings “to provide operational
flexibility” and buy the “most attractive securities on a
relative-value basis,” the New York Fed said.

Central bankers in the world’s largest economy are
struggling to bring down a jobless rate that has persisted at
9.5 percent or higher for 14 months. U.S. payrolls have declined
for four straight months as employees hired for the census were
fired and state and local governments eliminated positions to
balance budgets.

The Fed’s preferred gauge for consumer prices, which
excludes food and energy, rose 1.2 percent in September from a
year earlier, the slowest pace since 2001. Fed policy makers
have a long-run goal of 1.7 percent to 2 percent inflation they
see as consistent with achieving legislative mandates for
maximum employment and stable prices.

Employment Growth Slow

“The pace of recovery in output and employment continues
to be slow,” the FOMC said. “Currently, the unemployment rate
is elevated, and measures of underlying inflation are somewhat
low, relative to levels that the committee judges to be
consistent, over the longer run, with its dual mandate.”

Bernanke, 56, a former Princeton University economist who
studied the Great Depression, pressed forward with the move even
after five of 18 policy makers went public with objections or
doubts.

The one of the five who has a vote this year, Kansas City
Fed President Thomas Hoenig, today cast his seventh straight
dissent, the most at consecutive regular policy sessions since
1955. Hoenig was concerned that the “continued high level of
monetary accommodation” may “destabilize the economy” by
increasing long-term inflation expectations over time, the FOMC
statement said.

U.S. real gross domestic product, which is adjusted for
inflation, grew at a 2 percent annual pace in the third quarter,
faster than the 1.7 percent rate between April and June yet
still below what central bank officials believe is needed to
reduce unemployment.

Economic Projections

Economists in a Bloomberg News survey last month forecast
the unemployment rate will average 9.3 percent next year. Fed
governors and regional presidents presented updated economic
projections at this week’s meeting and will publish them in
minutes to be released Nov. 24.

Xerox Corp., the Norwalk, Connecticut-based printer and
business-services provider, said Oct. 21 it would cut 2,500 jobs
in the next 12 months. “I’m still cautious on the economy,
particularly in the large enterprise portion of the economy,”
Xerox Chief Executive Officer Ursula Burns said on a conference
call.

At Bentonville, Arkansas-based Wal-Mart Stores Inc., sales
at U.S. locations open at least a year have declined for five
consecutive quarters. Target Corp., based in Minneapolis, said
last month that it would lower prices on more than 1,000 toys to
attract shoppers.

‘Bottom Line’

“The bottom line is that fundamental problems remain in
the economy that monetary policy isn’t going to fix,” Ballew
said. “Risks remain out there that overly aggressive monetary
policy can cause unintended consequences.”

Still, the economy has shown some signs of a pickup. Retail
sales increased more than forecast in September, and
manufacturing expanded in October at the fastest pace in five
months.

Stocks have climbed and the dollar weakened in anticipation
of further Fed easing. Since Bernanke said Aug. 27 the Fed
“will do all that it can” to keep the recovery going, the
Standard & Poor’s 500 Index has gained 14 percent, and the
dollar declined 8 percent against a basket of six currencies.

Bond traders’ inflation expectations for the next five
years, measured by the breakeven rate between nominal and
inflation-indexed bonds, rose to 1.47 percent today from 1.44
percent yesterday and are up from 1.19 percent on Aug. 26.

Some Prices Gaining

Some measures of prices are gaining. Global food costs rose
26 percent in October from a year earlier, the fastest pace
since 2008, according to the United Nations Food and Agriculture
Organization. Gold futures traded in New York reached a record
$1,388.10 an ounce on Oct. 14 and are up 23 percent this year.

The Fed’s decision is the biggest in a marathon week of
worldwide central bank meetings. Australia and India yesterday
raised interest rates to cool inflation. Tomorrow, the Bank of
England may leave the door open to more aid to the U.K. economy
while the European Central Bank holds the line against price
increases. The Bank of Japan on Nov. 5 may accelerate stimulus
for its economy.

Bernanke’s renewal of asset purchases completes a full U-
turn this year. In February, the Fed raised the discount rate,
charged on direct loans to commercial banks, to 0.75 percent
from 0.50 percent. In March, it ended purchases of mortgage-
backed debt begun during the financial crisis. Bernanke
testified before Congress in March and July on how the Fed would
pare back record stimulus.

Recovery Slowing

Then, with the recovery slowing, the Fed in August decided
to halt the shrinking of its balance sheet by reinvesting
maturing mortgages into new Treasuries, setting a $2 trillion
floor on asset holdings. The next month, the Fed said it was
prepared to ease policy if needed and said for the first time
that too-low inflation, in addition to sluggish growth, would
warrant taking action.

Bernanke and other Fed policy makers have since signaled
the likelihood of printing money to start a new round of
securities buying. “There would appear -- all else being equal
-- to be a case for further action,” Bernanke said Oct. 15 at a
Boston Fed conference. “The risk of deflation is higher than
desirable.”

At the same time, “nonconventional policies have costs and
limitations that must be taken into account in judging whether
and how aggressively they should be used,” he said. One risk is
that the public becomes less confident in the Fed’s ability to
pare back stimulus and expects inflation above the central
bank’s desired level, a concern Bernanke said would be
“unjustified.”

Not Sure of Impact

Not all Fed officials are so sure of the impact.
Philadelphia Fed President Charles Plosser said Sept. 29 that he
doesn’t see how additional asset purchases will help employment
in the near term, and Narayana Kocherlakota of Minneapolis has
said a new round would probably have a “more muted effect”
than prior purchases.

St. Louis Fed President James Bullard in July warned of a
rising risk of Japanese-style deflation in the U.S. and called
for purchases of Treasuries as a response to any negative shock.
Japan’s economy has stagnated since the bursting of a stock-
market and real-estate bubble in the early 1990s.

Consumer prices in Japan have fallen for seven of the past
10 years, and gross domestic product, unadjusted for changes in
prices, was the smallest since 1991 last year. The country was
overtaken by China as the world’s No. 2 economy in the second
quarter.

Quantitative Easing

The Bank of Japan started quantitative easing in 2001,
pumping trillions of yen into the economy over five years
through injecting funds into bank reserves. The funds sat static
at commercial lenders’ accounts at the central bank and failed
to spark business investment and consumption.

The Fed purchases announced today will add to the $981
billion of excess deposits that banks held at the central bank
as of Oct. 20. Plosser said Oct. 22 that the funds are failing
to spur growth now and are “kindling” for money creation and
inflation in the future.